GOP's Hensarling Seeks Tighter Limits on Fed's Emergency Loan Power

Rules written by the Federal Reserve to comply with the Dodd-Frank Act leave the central bank with too much discretion to bail out failing institutions, contrary to the aims of the 2010 law, according to the chairman of the House Financial Services Committee.

The committee chairman, Texas Republican Jeb Hensarling, outlined objections to the Fed’s proposed regulations in a letter Monday to outgoing Fed Chairman Ben S. Bernanke. Fed officials drew up the rules on its emergency lending power to meet requirements of the Dodd-Frank Act intended to prevent bailouts of individual institutions in danger of failing.

“Disappointingly, the proposed rule does not provide any real or binding constraints on the Federal Reserve’s discretion to conduct bailouts of failing financial firms,” Hensarling wrote in Monday’s letter, according to a copy obtained by Bloomberg News.

Hensarling said the Fed “failed to suggest a clear methodology or criteria” for establishing parameters for the Fed’s use of its emergency lending authority under the Federal Reserve Act. Dodd-Frank requires that such loan programs be designed to provide liquidity to the financial system rather than to aid a failing financial company, and mandates safeguards to protect taxpayers from losses, Hensarling’s letter said.

“The letter will be considered, along with other public comments, as the Board considers the final rule,” said Federal Reserve Board spokesman David Skidmore.

Emergency Lending

The Fed’s normal channel of liquidity support is the discount window, where banks can receive direct loans after posting collateral. During the financial crisis, the Fed supplemented this by using emergency lending powers to support failing financial companies and troubled markets.

The Depression-era authority allowed the central bank to make loans to individuals, partnerships or corporations in “unusual and exigent circumstances.” The Fed invoked the power to support the commercial-paper market and primary dealers in government securities.

The Dodd-Frank Act said such lending should be limited to participants in a “facility with broad-based eligibility,” in effect limiting the Fed’s ability to support specific institutions.

The Fed on Dec. 23 proposed rules that closely followed the Dodd-Frank Act requirements. Hensarling asked Bernanke in the letter to consider additional constraints. He asked that the rule contain a prohibition that any borrower from the program use the funds to support a “separate insolvent firm,” and that the Fed define metrics for “broad-based” among other considerations.

Rules written by the Federal Reserve to comply with the Dodd-Frank Act leave the central bank with too much discretion to bail out failing institutions, contrary to the aims of the 2010 law, according to the chairman of the House Financial Services Committee.